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I guess I’m mostly finished with all the talk of the end of our financial world, so I’ll summarize.

During periods of deflation, especially with increasing FUD (fear, uncertainty and doubt), you want to be in cash. During times of low inflation and decreasing FUD, you might want to carefully be in stocks. During times of high inflation, especially with increasing FUD, you want to own stuff.

Cash means currency (the US dollar or something stronger), bank certificates of deposit (because they have very small penalties if you cash them in early), very short term bonds (US treasury bonds and perhaps the municipal bonds of states in good financial shape), and money market funds.

Be careful not to think of bond funds, especially medium or long-term bond funds as cash. The value of bonds goes down when interest rates go up. With interest rates at historical lows, you don’t want to own bond funds or long-term bonds. (I’m trying not to give advice, but, if you are in an intermediate to long-term bond fund or treasuries due in 5 to 30 years, get out quickly.)

If your 401K lets you choose between a stock fund, a bond fund, and a money market fund, then right now you probably want to be in the money market fund. If you think the US economy is improving or showing signs of improvement, then you’d want to choose a stock fund. If you think interest rates are going down, then, and only then, would you choose the bond fund.

Deflation means the value of stuff goes down (deflates) and the value of money goes up. Especially when people are fearful, they want to hang on to their money. Because money is dear, the demand for the stuff money buys goes down. When the demand for stuff goes down, the prices drift down. In other words, with deflation you can buy more stuff for the same amount of money. For example, the Deseret News recently published a price comparison of various consumer goods. The cost of a grocery cart of 15 items was $119.74 this time last year and only $116.08 this year. Money was worth more at the grocery store this year.

Inflation means the value of stuff goes up (inflates) and the value of money goes down. In other words, money buys less and less stuff. The same grocery cart of 15 items might cost $125.00 after a year of inflation. For most of us, inflation is what we know. When I was a child, a candy bar was a nickel. When I was a teenager, a Taco Bell burrito was 19 cents. Our first home was only $36,000, and we sold it a year later for $39,000.

During times of deflation, cash is your friend and debt is your enemy. You don’t want to owe money in times of deflation, because it costs more and more to repay a loan. During times of inflation, cash is better spent or invested in stuff and debts are generally easier and easier to pay down.

These definitions suggest you would want to own money (currency, treasury bonds, and government-insured bank CDs) during times of deflation, and own stuff during times of inflation. “Stuff” is things that are not measured in dollars, like real estate (acres or square feet), precious metals (ounces or bars), wheat (bushels), fuel (gallons, barrels, or BTUs), or stock (shares in a company).

Fear, uncertainty, and doubt complicate this simple picture. Stocks in general do poorly when FUD is high, no matter the inflation rate. When FUD is high precious metals may behave more like currencies, going up when logic suggests they should go down.

In summary, during times of deflation you want to own money and be free of debt, especially high-interest debt. During times of low-to-moderate inflation, you want to own stuff. If FUD is low, you could include stocks in your list of stuff. If FUD is high, you almost always don’t want stocks. During times of hyper-inflation, when FUD is bound to be high, you want to own stuff that people really need, like food, fuel, water and dry goods. Pete

Freedom Fest, mentioned in a previous post, got me thinking about scenarios. As I understand it, “scenario” comes from the Italian word for scenery and refers to an imagined or projected sequence of events. So, while I’m thinking about how to survive between now and the end of the world, I’m imagining a few scenarios. In these imaginings, I assume as true the following:

1) The USA is already spending much more money that it takes in. In fact, about 30 cents of every dollar we spend right now is borrowed.

2) The USA has made a lot of promises to pay for things without knowing how we will pay for them. These promises are the so-called “unfunded liabilities” for social security, healthcare, government-guaranteed mortgages, and government-guaranteed pensions.

3) Higher tax rates, which is viewed by some as a way of getting out of this mess, leads to lower tax revenues. As tax rates go up, taxpayers work harder to lower their taxes, mostly by using government-approved loopholes. As taxes go up, GDP tends to go down, which means the higher tax rates are offset by lower earnings.

4) Fear, uncertainty, and doubt (FUD) are bad for business. The many new regulations and pending tax hikes are producing more and more FUD.

To these assumptions we have to consider a lot of variables. How many seats will conservatives win in congress in November? Will a lame duck congress pass even more regulations and tax hikes? Will congress repeal Obamacare or the latest financial reform bill? Will the courts find Obamacare unconstitutional? Will President Obama win re-election? When will the Iraq and Afghanistan wars end? When will Iran attack Israel? How soon will congress tackle the unfunded liabilities.

Each different set of answers produces a different scenario. For example, one scenario might be that conservatives gain seats in the House and the Senate, but not enough to repeal Obamacare, that the courts invalidate parts of Obamacare but leave us wondering what to do next, that the wars go on indefinitely, that President Obama loses to Hillary Clinton in 2012, that Iran holds off on an Israeli attack, and that congress does very little to limit spending. Another could be that conservatives take back both houses of congress, Mitt Romney wins the presidency, Obamacare is repealed, the wars go on, Iran threatens an attack, and congress keeps on spending.

As I think through the possibilities, the results of each scenario are not as complicated as you might expect. In the short term, especially because of the FUD factor, the economy will sputter and flounder and recover a little and sputter again. Even though the government is spending, printing and borrowing like crazy, people are afraid to spend money. They hang on to the dollars they have. Employment remains high. In the short term, we can expect very low inflation or even deflation. In the short term, we would want to put our savings into things that increase in value during deflation.

In the medium term, the economy will continue to struggle along, but the bigger deficits will force interest rates higher. In any scenario I can dream up, I don’t see the government solving the spending problems quickly. As interest rates go up, inflation will start up again. In the medium term, we would want to put our savings into things that do well with moderate inflation. By “moderate inflation,” I mean 5 to 10 percent inflation per year.

In the long term, there is the chance the government could tackle its spending, but, if it did not, moderate inflation could turn into high inflation (10 to 20 percent) or hyper-inflation (20 percent per year up to 100% per day). If the government did not tackle spending and continued to print more and more money, we could go from moderate inflation to hyper-inflation almost overnight. In the case of hyper-inflation, investment decisions are the easiest. Pete

If we believe in the Bible, we know how this world ends. Just when Israel is on the brink of annihilation, Christ will come and usher in 1,000 years of peace. At some point between then and now, a lot of bad stuff that will happen. The problem, which I think about a lot, is how to get my family safely from now to then. Trusting “in the arm of flesh,” which I take to mean trusting in our own abilities and resources, or in the resources of governments, is a losing strategy. Still, it makes no sense to do nothing and simply hope God will save us from every inconvenience. The most logical course of action is, I think, is to trust in God, live good lives, stay cheerful, and prepare for whatever might happen.

So, what will happen? In addition to wars, earthquakes, plagues, and pestilences, there are bound to be a few inconveniences. The Internet might go down for a day or two, the cable could go out, and phone service might be spotty. The DVR might miss a few shows. Costco might stop giving out all those free samples.

In case you are wondering, I am not just trying to be funny. I want you to know that I know how ridiculous it is for me to try to avoid every difficulty. I know how foolish it is for me to think I could keep our savings intact in a complete financial meltdown.

What do I mean by a “complete financial meltdown?” The US dollar would become worthless, as would every other paper currency. If there is a severe shortage of food, precious metals would likely be worth very little. Any dollar denominated savings and investments would evaporate overnight. We would have to barter with what we have for what we need. Our survival would likely depend on how well we and our families, friends, and neighbors could work together to help one another. We would likely have to learn to live for an extended time without electricity, heat, air conditioning, or running water.

When could we expect such a meltdown? I have no idea. Lately we certainly seem to be intentionally speeding toward our national financial ruin, but the process could take ten or twenty years. The Zimbabwe dollar is still worth something. A fifty trillion dollar note is still worth 50 cents or so. We are so conditioned to value currency even when it has no intrinsic value that it will take some time for everyone to understand and believe how bad things are.

In the meantime, we can enjoy and perhaps even profit from our follies. As I quoted in the last email, “If you prepare for the end too soon, you could miss a lot of good trades.” I also like to compare our situation to a game of musical chairs. We might as well enjoy the music, even if all the chairs are gone. Pete

Early in July Marieta and I attended Freedom Fest in Las Vegas. Mark Skousen, who writes a financial newsletter I like to read, puts on the conference. He teaches economics (Columbia University), writes a lot of books, and loves free markets. His non-partisan, libertarian conference brings together all sorts of people. I was there for investment advice. Marieta came to keep me company.

We had a great time listening to all sorts of opinions. Here are a few:

“China has grown 8.2% per year over the last 40 years. Look to China.”

“China’s growth bubble is about to burst. Get out of China.”

“If government grows faster than GDP, you can’t get out of the [recession] box.”

“A killer wave is coming.” (Recession is the first wave. Then the bargain hunters come in hoping for an upturn. The Government continues to tax and spend, resulting in a killer wave, even bigger than the first wave, which takes everyone out. This theory came with a chart of what happened to the stock market in the Great Depression.)

“Something for nothing societies eat everything, including next year’s seeds.”

“When it is dark, you can see the stars.”

“All paper currencies will fail.”

“You can’t hedge against a complete collapse, so we don’t think about it.”

My favorite quote was, “If you prepare for the end too soon, you could miss a lot of good trades.”

There were a few political presenters. One debate was about Israel. George Gilder, an author I like a lot, was very pro-Israel. The other guy represented a group of Jews against Israel. He argued that the Jews should leave Israel to the poor, victimized Palestinians. He also hated Christians because they believed all Muslims would go to hell. Marieta and I were stunned at the very emotional comments, pro and con, from the audience.

A trade show was part of the conference. You could buy gold (8 booths), invest in oil drilling (5 booths), become a Libertarian (3 booths), buy investment newsletters (6 booths), buy investment books (12 booths), move your money to an offshore bank before the US government starts taxing your transfers in 2013 (3 booths), invest in foreign currencies (4 booths), find a broker or money manager (5 booths), and buy DVDs of all the conference presentations. (My booth numbers are approximate.) There were a few more unmemorable booths.

To and from the show Marieta and I listened to Gerald Lund’s book about the Willie and Martin pioneer handcart companies. My 2nd great-grandfather Jens O Peterson and his wife Anne went in the Willie company. Marieta also had a ancestors in the Willie company, of which one died at Rock Creek Hollow and another died at South Pass. The wonderful book was a weird accompaniment to the investment conference. The conference was all about protecting your savings in times of trouble, and the book was all about people with no savings and no resources just trying to survive and remain faithful.

I have a few thoughts on investing, which I will share in the next post. Pete